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May 29, 2008

A Minnesotan who owned a lot of Dell stock sat down to do some estate planning. Guided by an attorney, the taxpayer and his wife set up a family limited partnership for themselves and their four daughers. They immediately funded it with shares of Dell stock. A week or so later, they gifted partnership interests to their daughters. When they filed their gift tax returns for 1999, they reported the taxable gifts at a discounted value because they were in a partnership. They made additional gifts of discounted partnership interests over the next few years.

Valuation discounts are a big reason people establish family limited partnerships. The tax law considers a limited partnership interest to be a different animal than their underlying assets. Given a choice between buying Dell stock and an interest in a limited partnership owning Dell stock, people would rather just buy the stock. You can sell the stock with a phone call, but the LP interest is more trouble to unload. That's why the courts value LP interests at a discount.

The IRS attacked the taxpayer on several fronts. First, they said that the gift of the partnership interest was really in substance a gift of the stock. The IRS cited the Senda case, where the taxpayers were sloppy with their paperwork. The Tax Court this week said the Minnesota case is different:

The facts in the instant case are distinguishable from those of both the Shepherd and Senda cases. On November 3, 1999, the partnership was formed, petitioners transferred 70,000 Dell shares to the partnership, and Janelle, as trustee, transferred 100 Dell shares to the partnership. On account of those transfers, petitioners and Janelle received partnership interests proportional to the number of shares each transferred to the partnership. It was not until November 8, 1999, that petitioners are deemed to have made (and, on that date, they did make)5 a gift of LP units to Janelle, both as custodian for I. under the Minnesota UTMA and as trustee. Petitioners did not first transfer LP units to Janelle and then transfer Dell shares to the partnership, nor did they simultaneously transfer Dell shares to the partnership and LP units to Janelle.

They IRS also tried to collapse the partnership formation and the gift as a "step transaction," but the Tax Court disagreed. Finally, the IRS challenged the amount of the discount. It came out to be a duel of valuation experts, and here the IRS did better. The taxpayers expert argued for minority discounts of 10% to 15.3%, for gifts made in different years, and for lack of marketability discounts of 35% or more. The IRS expert argued for minority discounts of 3.4% to 14.8% and marketability discounts of 12.5%. The Tax Court settled on minority discounts from 4.53% to 14.34%; the Court allowed a 12.5% marketability discount.

The Moral? If you get the paperwork right and follow the formalities, you can make discounted gifts of interests in family partnerships holding only publicly-traded stock, but don't expect discounts of 30% or more.

Cite: Holman, 130 T.C. No. 12.

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